Why the FED should not Act!

The FED has added over a trillion dollars to its balance sheet in order to stimulate the economy. Using policies such as quantitative easing and operation twist, it has pledged to keep interest rates fixed through 2014.

Faced with a 1.9% growth rate of GDP and declining economic indicators, FED Chair Bernanke is contemplating taking further action.

If such action would help grow the economy or solve the unemployment problem, we would be in favor of it. However, there is every indication to believe that it will not move the economy at all and may do more damage than good.

Here are the reasons why the FED should not take further action at this time.

  1. Low interest rates do not matter if banks are not willing to lend to consumers and small businesses and corporations are able to borrow money on not willing to invest it.
  2. The evidence suggests that the greatest beneficiaries of the lowest rate policy are the corporations that need loans the least.
  3. Higher interest rates, rather than low interest rates, may actually increase borrowing and spending because they would provide a greater reward to lenders for taking on riskier loans and home mortgages. Hence mortgages, consumer loans and small-business loans may be easier to get if rates were higher.
  4. By keeping short-term interest rates pegged near zero and pushing long-term rates below 2%, Bernanke runs the risk of persuading businesses and consumers that the recovery is doomed. That message will encourage them to start hoarding cash rather than spending and investing it.
  5. Low rates that fixed for years into the future are a signal that the Fed is not confident in the economy. Therefore, neither will be investors and consumers.
  6. Since World War II, economic recoveries have lasted about five years on average. The current recovery has lasted more than three years. Therefore, one can expect the economy to enter into a recession sometime within the next year or so. If that does happen, the FED will have exhausted its resources to fight it.

The Federal Reserve policies under Chairman Bernanke help get us to where we are. But now it is time to reconsider the low interest rate policy. Low rates have made it easier for big corporations and banks to borrow money, while consumers and small-business owners have been left out in the cold –unless they have near perfect credit records.

Corporations and banks used the cheap money to clean up their balance sheets and buildup cash reserves, rather than investing.

Any further actions the FED might take would only add to the cash hoards of corporations, without making a dent in economic growth.

For now, the Federal Reserve’s low interest rate policies may have passed their useful life span.